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SEC Suit Alleges Penny Stock Fraud

Bloomberg Law®, an integrated legal research and business intelligence solution, combines trusted news and analysis with cutting-edge technology to provide legal professionals tools to be...

The Securities and Exchange Commission Dec. 21 sued four individuals and 12 entities alleging that they ran a penny stock fraud scheme in which they acquired unregistered microcap company shares at discounted prices and subsequently sold them while falsely claiming registration exemptions under federal securities laws (SEC v. Garber, S.D.N.Y., 12 Civ. 9339 (SAS), 12/21/12).

The SEC complaint in the U.S. District Court for the Southern District of New York named Danny Garber, Kenneth Yellin, Jordan Feinstein, and Michael Manis in addition to the 12 entities as defendants. Yellin, Garber, and Feinstein are all former registered representatives, according to the SEC.

According to the SEC, from 2007 until 2010, the defendants acquired unregistered shares in microcap companies at about 30 to 60 percent discount by assuring the companies that they would not immediately resell the shares but intended to hold them for investment purposes. However, according to the SEC, the defendants immediately resold the shares, fraudulently claiming the shares were exempt from registration under Regulation D of the 1933 Securities Act for transactions that meet certain state law exemptions.

By creating virtual corporate presences in Minnesota, Texas, and Delaware, the defendants fraudulently created an appearance of compliance with the claimed exemption, the SEC said. Further, the complaint continued, the defendants obtained attorney opinion letters that referenced the defendants' alleged plan to hold on to the shares for investment purposes and also confirmed the validity of the claimed exemption. Using these opinion letters, the defendants obtained stock certificates without restrictive legends, thereby allowing them to resell the shares soon after obtaining them, the SEC said. By immediately dumping the fraudulently obtained shares on the market, the defendants realized approximately $17 million in virtually guaranteed proceeds, the complaint alleged.

Additionally, in some cases, the defendants purchased convertible notes representing debts owed by the microcap companies to third parties and then converted the debts into unregistered shares and immediately sold them in violation of Rule 144 of the '33 Act, the SEC said. Again, the defendants used attorney opinion letters to support their claim that they had satisfied the Rule 144 holding period requirement and could issue the stock certificates without restrictive legends.

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